漢瑞祥 (HSIC) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Henry Schein Third Quarter Conference Call.

(Operator Instructions) As a reminder, this call is being recorded.

I would now like to introduce your host for today's call, Carolynne Borders, Henry Schein's Vice President of Investor Relations.

Please go ahead, Carolynne.

Thank you, Chantella, and thanks to each of you for joining us to discuss Henry Schein's results for the third quarter of 2017.

With me on the call today are Stanley Bergman, Chairman of the Board and Chief Executive Officer of Henry Schein; and Steven Paladino, Executive Vice President and Chief Financial Officer.

Before we begin, I would like to state that certain comments made during the call will include information that is forward-looking.

As you know, risks and uncertainties involved in the company's business may affect the matters referred to in forward-looking statements.

As a result, the company's performance may materially differ from those expressed in or indicated by such forward-looking statements.

These forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein's filings with the Securities and Exchange Commission.

In addition, all comments about the markets we serve, including end-of-market growth rates and market share, are based upon the company's internal analysis and estimates.

The contents of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, November 6, 2017.

Henry Schein undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call.

(Operator Instructions)

With that, I would like to turn the call over to Stanley Bergman.

Thank you, Carolynne, and good morning, everyone, and thank you for joining us.

I'd like to start today's call by making a few high-level comments.

Our sales results for the third quarter was solid overall and reflect continued success with our comprehensive offering of products and value-added services that drive internal growth bolstered by strategic acquisitions.

This combination of internal growth and complementary acquisitions is at the heart of our business model.

Third quarter sales growth was negatively impacted by the recent hurricanes in the U.S. as well as a difficult comparable in dental equipment sales.

We have a track record -- a solid track record, I might add, of gaining market share with a combination of internal sales growth and acquisition growth.

Our normalized internal local currency growth has been in the range of 4% to 6% for the past 14 quarters, built on years of great success in internal local currency growth.

This has been supplemented by approximately 1% to 5% of acquisition growth over the same period.

So the track record on sales is a good one, and we remain confident that we will continue to build on this track record.

Steven will review our 2017 and '18 guidance in a bit more detail later.

During 2018 and beyond, we expect to continue to make progress with our focus on increasing sales of higher-margin products across all of our businesses as well as improving operating efficiencies to achieve long-term EPS growth.

We are confident and indeed excited about our long-term prospects and believe we are very well positioned in the markets we serve to continue to increase market share through internal growth supplemented by strategic acquisitions, while increasing operating margin.

Let me now ask Steven to review our financial results, and then I'll provide some additional commentary on our recent business performance and accomplishments.

Steven?

Okay.

Thank you, Stanley, and good morning to all.

As we begin, let me first point out that all of our per share amounts that I will be discussing today reflect the 2-for-1 stock split that we recently completed.

In addition, last year's Q3 2016 results include restructuring costs of $5.4 million pretax or $0.02 per diluted share.

As Stanley mentioned, our 2017 third quarter results were negatively impacted by the recent hurricanes in the U.S., among other factors that I'll discuss in more detail in a moment.

While it is difficult to quantify the precise impact, we estimate that the hurricanes negatively impacted our worldwide sales growth by approximately 30 basis points and negatively impacted our EPS by approximately $0.005.

So I'll also be discussing our results on an as-reported GAAP basis and also on a non-GAAP basis, and that non-GAAP basis excludes the prior year restructuring costs.

On a year-to-date non-GAAP measure, the current year-to-date also excludes litigation settlement expense.

We believe that the non-GAAP financial measures provide investors with useful information about the financial performance of our business and enables the comparison of financial results between periods where certain items may vary, independent of business performance and allows for greater transparency with respect to key metrics used by management in operating our business.

These non-GAAP financial measures are presented solely for informational and comparative purposes and should not be regarded as a replacement for the corresponding GAAP measures.

You could see an Exhibit C of this morning's earnings release, a reconciliation as well as a reconciliation that's provided on our Investor Relations section of our website.

So turning to our results for the quarter.

Our net sales for the quarter ended September 30, 2017, were $3.2 billion, reflecting a 10.3% increase compared with the third quarter of 2016.

This consisted of 8.8% growth in local currencies and a 1.5% increase related to foreign currency exchange.

In local currencies, internally generated sales increased 4.8% and acquisition growth contributed an additional 4.0% growth.

Again, we estimate that the hurricanes negatively impacted our worldwide sales growth by approximately 30 basis points.

You could also see the details of our sales growth that are contained in Exhibit A of our earnings news release that was issued earlier this morning.

If you look at operating margin for the third quarter of 2017, it was 6.8% and contracted by 25 basis points compared with the third quarter of 2016.

Some additional details on our operating margin in Q3.

The first relates to the inclusion of restructuring costs in last year's third quarter.

These restructuring costs in the prior year favorably impacted operating margin comparisons by 19 basis points.

Secondly, sales of influenza vaccines in the third quarter of 2017 negatively impacted our operating margin comparison by about 14 basis points.

And the third item relates to acquisitions completed during the past 12 months and related expenses, which combined to negatively impact our operating margin comparison by 7 basis points.

Excluding the net impact of these items, our operating margin contracted by approximately 23 basis points year-over-year.

I think it's important to also note that on a year-to-date basis, excluding the impact of these same factors as well as the litigation settlement expense in last quarter, our operating margin expanded by 6 basis points.

So I'd like to discuss a little bit our gross margins, which were negatively influenced by 3 primary factors.

The first was product mix.

Given that the lower gross margin in Medical and Animal Health businesses have been growing at a faster rate than higher-margin dental sales, our overall gross profit has been impacted by that product mix.

There was also product mix that negatively impacted within each of Medical and our Animal Health businesses.

Secondly, our U.S. dental special markets business had lower margins, where we took the opportunity to expand a number of multiyear contracts with key dental support organizations or DSOs.

And third, we saw lower gross margins in our European Dental business, in particular, in Germany.

These factors were partially offset by lower expenses as a percentage of sales, as we continue to realize operating efficiencies from previous restructuring efforts, and we continue to leverage our infrastructure and control expenses.

If we look at our reported GAAP effective tax rate for the third quarter of 2017, it was 29.0%.

This compares to 28.9% GAAP effective tax rate in the third quarter of last year 2016 or 28.7% on a non-GAAP basis for the third quarter of 2016.

That non-GAAP basis last year also excludes the income tax benefit on restructuring costs.

We expect the 2017 full year effective tax rate to be in the 28% range on a GAAP basis and 27% range when excluding the estimated loss on our divestiture of E4D, which we estimate to be about $17 million to $18 million.

And both Stanley and I will discuss that in greater detail.

But that is a Q4 event since the transaction closed in early Q4.

For 2018, we expect the effective tax rate to be a little bit higher, to be in the range of 28% and 29%.

And this increase over 2017 is primarily because of the ASU 2016-09 accounting literature, which relates to tax benefits on stock-based compensation.

This standard primarily impacts us in Q1 each year as this was when the majority of our stock-based awards vest at Henry Schein.

We expect a higher tax rate based on the estimated share price and the number of shares that are expected to vest in 2018.

This higher tax rate will of course negatively impact our 2018 diluted EPS growth assumptions since we expect the tax benefit from stock-based compensation to be less in 2018 than it was in 2017.

Moving on to net income attributable to Henry Schein for the third quarter of 2017.

It was $138.0 million or $0.87 per diluted share.

This compares with the GAAP results for the third quarter of 2016 and represents growth of 3.2% and 6.1%, respectively.

Compared with the non-GAAP results for third quarter of 2016, this represents growth of 0.2% and 3.6%, respectively.

I'll also note that foreign exchange had a positive impact on our diluted EPS for the quarter of almost $0.01.

Let me provide some additional detail on our sales results for the quarter.

Our dental sales in the third quarter of 2017 increased 11.1% to $1.5 billion.

Internally generated sales in local currencies were up 1.6%.

Acquisitions contributed 7.5% and there was a 2.0% increase to foreign exchange.

Our North American internal sales growth in local currencies was 0.8% and included 1.3% growth in sales of dental consumable merchandise.

The growth in consumable products was negatively impacted by approximately 50 basis points as a result of the recent hurricanes and an additional approximately 90 basis points due to a loss of a previously disclosed DSO contract.

Our internal sales growth in local currencies would have been 2.7% without these 2 factors.

We also expect stable market growth for the dental consumable merchandise business going forward.

Our North American dental equipment sales and service revenue declined by 0.7% for the quarter.

This is primarily related to a difficult prior year comparison in which internal sales growth was 13.3% in local currency.

That growth was in part due to a very successful sales promotion in the prior year.

Also, our dental equipment sales growth was negatively impacted by approximately 60 basis points from the hurricanes and by approximately an additional 110 basis points from the loss of that same previously disclosed DSO contract.

However, it's important also to note that at the end of the quarter, our equipment backlog continued to remain healthy.

So early in the fourth quarter, we divested our 21.4% equity ownership of E4D technologies, the manufacture of the Planmeca CAD/CAM system.

We will continue to distribute the Planmeca line of CAD/CAM products in the U.S. and Canada on a nonexclusive basis and in Australia and New Zealand on an exclusive basis.

Planmeca manufactures a highly respected brand of advanced digital dental solutions, and we are pleased to continue to represent their products to Henry Schein customers.

The divestiture is expected to generate a onetime noncash charge of between $17 million and $18 million or $0.10 to $0.11 per diluted share in Q4 2017.

Turning to international.

Our international dental internal growth in local currencies was 3.2% and included 3.4% growth in sales of dental consumable merchandise and 2.6% growth in dental equipment sales and service revenue.

Our Animal Health sales were $882.6 million for the third quarter, which was an increase of 11.7%.

Here, we see internal generated sales growth in local currencies, and local currencies was up 8.0%.

Acquisitions contributed an additional 1.9%, and there was a 1.8% increase due to foreign exchange.

The 8.0% internal growth in local currencies included 9.0% growth in North America and 6.9% growth internationally.

About 30 basis points of sales growth in North America was from certain products switching between agency sales and direct sales, resulting in a normalized growth of about 8.7%.

Also, the sales growth in North America also included a negative impact from the hurricanes of about 50 basis points.

We believe the strong sales growth reflects a healthy end market and our commitment to offering a wide range of products and value-added solutions.

Turning to Medical sales.

They were $690.8 million for the third quarter, an increase of 8.0%.

Internally generated sales in local currencies were up 7.8%.

Acquisitions contributed an additional 0.1% and an increase in foreign exchange with the remaining 0.1%.

Of that 7.8% internal growth in local currencies, it included 7.9% in North America and that 7.9% also includes a negative impact of hurricanes of about 25 basis points.

And the international internal growth in local currencies was 4.5%.

We are very pleased with our Medical growth, which was primarily driven by strong organic growth from existing larger customers.

Our Technology and Value-Added Services sales were $109 million in the quarter, an increase of 4.1%.

Internally generated sales in local currencies were up 3.0%, acquisitions, an additional 0.7% and 0.4% due to foreign exchange.

The 3% internal growth in local currencies included 2% growth in North America and 8.7% growth internationally.

I think it's important to note that within North America, that 2% growth reflects lower dental software sales and financial services revenue versus the prior year's quarter.

The financial services revenue was primarily related to lower dental equipment sales.

Obviously, as we have lower sales, we finance less equipment because of the lower sales.

We don't believe that there was any significant impact on the technology business related to the hurricanes.

In the international market, we had strong growth of 8.7% highlighted by strong veterinary software revenue growth.

Related to stock repurchase.

We continue to repurchase common stock in the open market during the third quarter.

More specifically, during Q3, we spent about $125 million to repurchase approximately 1.4 million shares.

The impact of this repurchase on our third quarter diluted EPS was not material.

On September 18, 2017, we announced that our Board of Directors authorized the repurchase of up to an additional $400 million of shares of our common stock.

So at the close of the third quarter, Henry Schein had approximately $425 million authorized for future repurchases of our common stock.

Our capital allocation strategy is focusing on deploying a large portion of our annual free cash flow to both share repurchases and M&A activities.

We believe this strategy is a key component of our commitment to increasing shareholder value.

If we take a brief look at some of the highlights of our balance sheet and cash flow, operating cash flow was $131.4 million compared to $178.6 million in the third quarter of last year, and we believe we'll continue to have strong operating cash flow for the year.

Our accounts receivable days sales outstanding were virtually unchanged over last year, and inventory turns increased slightly by 0.1 turn on the current year.

So let me just conclude my remarks by discussing our 2017 and '18 financial guidance.

For 2017, we now expect GAAP diluted EPS attributable to Henry Schein, and that includes the litigation settlement expenses to be $3.46 to $3.48, and that guidance reflects growth of 12% compared to the 2006 GAAP guidance or GAAP actual results, sorry, of $3.10.

We are adjusting our 2017 non-GAAP guidance range, and now expect non-GAAP diluted EPS, which excludes the litigation settlement expenses as well as the Q4 loss associated with the E4D divestiture to be in the range of $3.59 to $3.61.

This guidance reflects growth of 8% to 9% compared with 2016 non-GAAP diluted EPS of $3.31.

And that $3.31 in the prior year also excludes the restructuring costs.

So looking at Q4, we expect the U.S. dental market conditions to continue to be stable.

I'll also note that we expect onetime integration costs of approximately $1.3 million related to the integration of Merritt Veterinary Supplies as we consolidate the Merritt distribution centers into the existing Henry Schein facilities and combine our systems.

We also expect continued lower gross margins in both Europe and the new DSO contracts, although we expect these lower gross margins will be partially mitigated by lower operating expenses.

For fiscal 2017, it includes 1 less week than 2016.

Note also that our guidance for 2017 EPS attributable to Henry Schein is for current continuing operations as well as any completed or previously announced acquisition, but does not include the impact of potential future unannounced acquisitions, if any.

Guidance will also assume that the foreign exchange rates are generally consistent with current levels.

Turning to next year, we are introducing guidance for 2018 at this time.

Please note that our 2018 guidance is based on current revenue recognition standards.

However, we do not believe that the impact of the new revenue recognition standard ASC 606 will be material to our earnings results.

We are continuing to review that situation and should that be different, we'll obviously update shareholders.

For 2018, we expect diluted EPS attributable to Henry Schein to be $3.85 to $3.96.

That reflects growth of 11% to 14% compared with the midpoint of our 2017 GAAP guidance and growth of 7% to 10% compared with the midpoint of our 2017 non-GAAP guidance range.

As a reminder, we expect to have less stock-based compensation tax benefit in 2018 than we did in 2017.

Therefore, we are guiding towards a effective tax rate of 1 to 2 percentage points higher than the 2017 rate.

We would also expect that the lower gross margins that we've experienced in Europe as well as in the U.S. related to the new DSO contracts will continue until it annualizes later -- or late in 2018.

Again, this guidance assumes that our end markets remain stable and are consistent with current market conditions.

The 2018 guidance attributable -- EPS guidance attributable to Henry Schein is for continuing operations again as well as any completed or previously announced acquisitions and does not include the impact of any potential future acquisitions, if any.

And again, we assume that foreign exchange rates are consistent with current levels.

So with that summary, let me now turn the call back to Stanley.

Thank you, Steven.

We believe Henry Schein serves the largest worldwide base of Dental, Animal Health and Medical office-based practitioners.

And we remain confident in our ability to continue to drive EPS growth through increased sales and margins completed by -- complemented by operating efficiencies driven through our unique infrastructure and strong value-added services offering.

We have believed in the statement now for the 22 years that we've been a public company and remain confident as ever that we as a company are well positioned to continue sales growth through internal local currency growth coupled with synergistic acquisition growth.

Excluding the impact of the hurricanes and the loss of the previously disclosed DSO contract, our internal growth in local currencies in the third quarter was 5.4%.

We believe that, that is at least 2x, if not more, the market growth.

We have a solid track record of gaining market share with normalized internal local currency growth, which has been in the range of 4% to 6% for the past 14 quarters.

I started the call this way and I'd like to stress this.

And, of course, even before that 14 -- in the last 14 quarters, the track record has been outstanding.

We remain confident that we can supplement our internal local currency growth with synergistic acquisitions.

We have a policy of not talking about acquisitions specifically until the acquisition is closed.

And so we do not want to count our chickens before they're hatched, but we do have a decent pipeline of acquisitions, of M&A investments and putting money to work -- capital to work, so that we could increase our synergies over time and driving operating income, and so, EPS growth.

We have as a priority, a plan to increase sales of higher-margin products, continue to drive gross -- and so continue to drive gross margin improvements.

We believe we can enhance our offering with additional technology and other solutions, include specialty products, product exclusives and the Henry Schein brand and other controlled solutions to name a few areas of focus.

At Henry Schein, we have a long-standing ongoing commitment to efficiency in all that we do.

Of course, at our world-class distribution centers, in the field through our field sales consults and regional offices and, of course, here at corporate head office and through streamlining acquired businesses.

We are constantly looking for ways to be more efficient, all the while maintaining our commitment to best-in-class customer service and order accuracy that Henry Schein is known for throughout the world.

We are also committed to the success of our manufacturing partners, no less today than ever before, and of course, to the growth and profitability of our Dental, Animal Health and physician/customer practices, which is at the heart of our strategy.

With that background, let me now begin my review of our full business units with Dental.

The North American dental consumable merchandise internal growth in local currency was 2.7% when excluding the impact of the hurricanes and the loss of previously disclosed DSO -- and the previously disclosed DSO contract.

Again, we believe we continue to gain market share in this market.

Based on our current view, we continue to expect stable market growth for dental consumable merchandise across North America.

We believe the domestic dental market should realize unit growth improvement over time, driven by demographics of the aging population as well as by an emphasis that is gaining momentum, showing the link between good [or okay] and overall health.

North American dental equipment internal growth in local currencies faced the tough prior-year comparison, as Steven mentioned.

However, we see continued capital equipment investments by North American practices, which is indeed encouraging as we consider the health and stability of the broader end market.

One of the areas we are most excited about in the dental professions is the dental profession's continued adoption of digital technologies.

We are fully committed to offering a broad set of digital solutions on behalf of all of our manufacturing partners aimed at realizing greater practice efficiencies and enhance patient satisfaction.

In addition, we are pleased with the initial reception from dental customers in North America, following the addition of the full line of DENTSPLY SIRONA dental equipment.

We believe that practices leveraging dental technologies not only increase the efficiency of the diagnosis and effectiveness of the diagnosis treatments and productivity with existing patients, but advanced technologies will also drive greater patient flow through the practitioners' offices due to the enhanced services they offer.

This is the most exciting dental strategy advance -- at the moment at Henry Schein, advancing of digital technology in our customers' offices.

Henry Schein now has access to a wide and comprehensive offering of digital prosthetic equipment solutions and, therefore, as Steven mentioned, we divested our equity interest in E4D technologies a few weeks ago.

This is a logical step in the evolution of our goal to offer a broad selection of dental equipment solutions to our customers through an open architecture market approach.

The Planmeca restorative system, including the Emerald digital intraoral scanner, which has recently been released, will continue to be an important offering, enabling dental practitioners to deliver high quality one-visit dental restorations.

We are looking forward to continuing to represent the Planmeca CAD/CAM brand as part of our efforts to advance our leadership position in the dental digital marketplace.

We believe CAD/CAM represents an attractive long term growth opportunity.

We will continue to represent the complete lines of equipment from other key suppliers as well, including 3M, 3Shape, A-dec, Danaher, Ivoclar, Midmark, Planmeca and many others.

Also, we continue to be well positioned in the Global Dental lab markets, providing solutions for digital restorations that are outsourced to laboratory facility.

We also now have access to a broad line of digital prosthetic materials.

And as a result, recently divested our ownership position in a company that produces materials used for manufacturing dental restorations and distributes lab products in China.

Our investment provided us with access to high-quality Zirconia products, a clinically advanced prosthetic material used in digital dentistry.

Today, we are well positioned globally with our supplier Zirconia and other CAD/CAM related materials and, therefore, elected to divest of this position.

There was a slight gain on this divestiture in the third quarter.

So I have to say that we are very pleased today with our comprehensive offering of all digital equipment and related materials from imaging to digital prosthetics in the office, the operatory and also in the dental laboratory.

It's been a long journey to get to this point, but we are finally here and I'm very, very pleased with our offering and our commitment to open architecture that is so well connected with our digital practice management platform and related clinical workstation that we offer to our customers.

Both in small, medium size, large practices, institutions like dental schools and elsewhere, including the U.S. Military.

On the international front, dental consumable merchandise and dental equipment internal sales in local currencies both grew in the low-single digits.

In particular, we are pleased about dental specialties internal local currency sales performance, which increased by 10% in the third quarter.

Our global implant, orthodontic, endodontic and other dental surgical solutions continues to be well received in the marketplace.

Relative to our plan to expand our dental specialty product sales, our endodontic specialties subsidiary recently made an investment in Edge Endo as an additional source of endodontic products for our dental practitioners and for the dental -- for the Endo platform that we have.

Edge Endo in 2016 had sales of approximately $17 million.

We are pleased that the Edge Endo product offering will now be available to our customers in our dental specialty arena and they will in turn supply additional innovative endodontic products to complement our portfolio of solutions in the endodontic area.

Let me now touch on the Animal Health business.

Our sales performance in the Animal Health business in the third quarter reflect strong execution across our global business.

These markets continue to remain healthy with growth in North America driven by our focus on the companion animal segment.

We believe this growth is due to the breadth of our value-added solutions offering, including an enhanced product portfolio featuring software, diagnostic equipment and surgical instruments.

During the quarter, we announced and closed on our acquisition of Merritt Veterinary Supplies, which is one of the nation's largest independent regional veterinary suppliers with sales in 2016 of approximately $115 million.

Merritt serves approximately 4,500 veterinary clinics and will become part of the Henry Schein Animal Health group.

We believe Merritt will meaningfully add to the scale of our U.S. Animal Health business, while reinforcing our existing presence across the Eastern U.S. It also will benefit our diagnostic equipment surgical instrument businesses, including skilled crews and veterinary instrumentation.

We expect Merritt to be accretive to earnings per share beginning -- at the beginning of 2018.

Now let me address the activities in our Medical group.

Solid internal sales growth in local currencies of 7.8% was driven by contributions from large group practice -- from the large group practice segment of the market we have focused on for some time.

This success reflects our commitment to solutions that help customers provide quality care and increased value in the delivery of health care services.

In keeping with our desire to expand our offering of specialized solutions that help physicians provide high-quality care, we announced an agreement with Cerebral Assessment Systems to distribute Cognivue.

This is the first computer devised Cognitive Assessment screening device cleared by the FDA to detect early signs of dementia.

We also entered into an exclusive agreement with Terason to distribute its uSmart 3200T portable ultrasound device.

This product enables emergency responders to perform exams in medical transport patient vehicles and in aircrafts, and alert emergency room staff of relevant patient vitals while the patient is in transit.

Our customers rely on us to offer technology, advanced devices such as this to help triage traumatic situations that require quick decision-making and treatment.

So now the final group, the Technology and Value-Added Services group.

As Steve noted, our results in North America reflect lower dental software sales.

During the quarter, we refocused a significant portion of our technology sales force as we prepared to launch the DENTSPLY SIRONA dental equipment product line this past September.

With this initial ramp up, we expect our software sales in the fourth quarter to improve sequentially.

Let me also point out that now with some of the larger accounts that we are providing services to on the software side, sales can be somewhat lumpy.

Indeed, a prime example of our Value-Added solutions portfolio is our software expertise.

Our solutions help customers' cost efficiently manage their practice while identifying new ways to attract and retain clients.

This could be through clinical workflow integration between patient records, equipment, laboratory connectivity, inventory management tools or marketing campaign.

It is our consultative approach paired with our commitment to building technological solutions around a practice's specific needs that makes us such a valued partner to our customers.

A highlight in this business has been market reception of our cloud-based Practice Management solution known as Dentrix Ascend.

With this versatile software platform, solo and now multiple site practices can manage their practices with advanced next-generation practice management capabilities, store practice data in the cloud and access information about their practice at that time.

This is especially important for dentists who practice in multiple sites that require access to patient information from any location so that they can create reports, track patient's care in centralized business operations.

With continued pressure on dental practices to remain efficient and productive, Dentrix Ascend is an excellent tool for streamlining practice process -- processes for a wide spectrum of dental practices.

But let me stress, particularly for the growing and larger dental practice group practices who are now seeking efficient software in the cloud.

Of course, a highlight of our business has been our partnership with Cerner, Leidos and Accenture in servicing the health care management systems modernizing the Department of Defense digital platform in dentistry.

The rollout of the electronic medical record system is making good progress with 3 military sites live and functioning an [effortive] process.

According to the Defense Department, this project will support the availability of electronic health record to more than 9.4 million Department of Defense beneficiaries and approximately 205,000 military health system personnel globally.

We are most pleased to be part of this very important project.

So a couple of closing comments before we take questions.

And let me just reflect for a moment on a series of natural disasters across the U.S. over the past couple of months that have tested our nation.

We are committed to providing relief organizations with health care supplies that need to support public health, so communities can get back on their feet and begin the work.

We're also committed to working with our customers to get them back on their feet, whether this means activating helplines or joining appropriate symposium on practice recovery as we have already done in Houston.

In line with this, Henry Schein and its supplier partners have donated more than $600,000 of cash and products to relief organizations and associations working in the hurricane-affected areas in the southern part of the U.S. and in the Caribbean.

We are working directly with organizations that can make a difference underground.

And of course, our hearts go out to those that were tragically killed yesterday in Texas.

On a more positive note, Henry Schein recently celebrated important milestones with the 25th anniversary of our Indianapolis distribution center and the 15th anniversary of the Jacksonville facility, 2 of our 5 core distribution centers in the U.S. These are extremely productive distribution centers customized for the needs of the office-based practitioner.

We thank the Team Schein Members in all of our distribution centers and all of our distribution centers across the company in the U.S. and globally for the Henry Schein success on the distribution side.

So with -- that concludes my -- Steven and my prepared remarks, and we are now pleased to answer questions from participants.

Thank you.

Operator?

(Operator Instructions) Your first question will come from the line of Kevin Ellich with Craig-Hallum.

I guess, Steve, wanted to go back to your comments on gross margin.

Could you quantify or give us a little bit more detail on the 3 factors that you laid out: the product mix, dental specialty in European, dental in Germany?

And how much of an impact do you think that will have in 2018?

Yes, well, let me -- we're not going to be very specific on that, but I would say that probably, the largest impact was the European Dental business, which probably had the biggest impact in gross margins.

I think it's important to note that we see that as something that as we continue to build out our Value-Added services in Europe that are not as advanced as we do have in the U.S. So for example in Germany, we don't have software solutions among other Value-Added services.

So we do think there is opportunity to improve those margins over time, and of course, we're looking at operating expense efficiencies also.

So that was probably the largest.

The second largest was probably product mix, where product mix worked against us.

We're the fastest-growing businesses with the slowest margin.

And then even within Medical and Animal Health, we had some mix issues, specifically in Medical, we had lower gross margins on flu vaccine versus a year ago.

And the last was special markets or Dental Support Organizations.

But we've mentioned that even though it was smaller than the current quarter, it will be a little bit larger in Q4 and into 2018 until those contracts annualize.

We're also working at being more efficient to improve the profitability of those contracts over time, but that's still something we're working on.

And then Steve, on the guidance for '18.

How much of an impact does the divestment of E4D -- of your investment in E4D have on the EPS guidance?

Yes, really very little because we picked up, in the affiliate income, our share of the gain or loss.

But we'll continue to sell the E4D products and we would expect that sales would be still good.

And remember, we only have a small interest, about 20% in E4D.

So really not significant impact on the EPS.

Your next question will come from the line of Sarah James with Piper Jaffray.

I appreciate the comments on the headwinds and tailwinds driving your 2018 guidance.

But I wanted to clarify a few items.

So you said that you expect dental consumables to improve over time.

Was that counted in 2018 guidance?

Or are you talking about longer term?

Then on DSO contracts, does your guidance assume any improvement in margins over the course of the contract?

Yes, so I'll comment on improving dental markets.

It was really a longer-term comment, we really have not factored that in at this time in 2018.

So we'll wait and see how that turns out.

And if we see an improvement, then of course, there'll be some upside.

With respect to DSO contracts, we have initiatives where we think we can improve the -- by the way, they're still profitable, so it's not like they're not profitable, but we do want to improve the profitability of DSO contracts.

We're being a bit conservative there because that's still work in process, so there's still some opportunity there in 2018 should we do better than what's in that guidance.

Your next question comes from the line of Robert Jones with Goldman Sachs.

Just looking at the North American dental consumables in the quarter, it sounds like adjusting for the hurricane and the DSO loss, growth would have been closer to around 2.7%, somewhere in that neighborhood.

I'm wondering how would you guys characterize the health of the North American end market that you saw in the quarter.

And then if you could, I think last quarter, you provided some helpful insight into the breakdown between price and volume within the growth you saw in North American dental consumables.

That'll be helpful.

I think that's the key question and I think a question that some investors would like answered.

It's very hard to give you a precise answer.

Having said that, just attended the meeting of the American College of Prosthodontists.

And the question I get is that visits are stable.

There are parts of the country with a little bit of hit.

We're seeing a little bit increased number of procedures.

But generally, I would say it's flat.

Furthermore, I would say that inflation is very, very little.

It is a little bit, but there's also a movement more towards generics, towards corporate brands.

And I would say even in some areas, a movement towards lower-cost brand.

So overall, that would be -- that was the only change all other things being equal, it would improve our margin.

But generally, I would say the market is stable, and, in terms of units and there is a little bit of price -- net price inflation, but not much because the price increases of the branded manufacturers are being mitigated by the use of corporate brand generics and lower-cost brands.

So I would say that the market is relatively stable.

Longer term, and we are not contemplating this in our budgeting and, in fact, in our strategic plan for the next 3 years because we'd rather be conservative, we're expecting the market in the U.S. in North America in terms of units to be stable with very slight increase in prices as some of the bigger customers move their volume towards more generic type products, which are not -- it's not bad from our margin point of view, but at least I think we need to be a little bit more conservative.

Got it.

And then, I guess, just Steve, the company targets about 20 basis points of organic operating margin expansion each year.

Looks like this year, you're trending a little bit below that target.

I guess, what's the impact this year?

And then how should we think about your ability to expand margins next year?

What's reflected in the 2018 guidance closer to that 20 bps target?

So for the current year, we will be below that 20 basis points target.

And as I said for 9 months, we were on a normalized basis about 6 basis points.

Typically, Q4 is a strong margin for us because of strong sales of technology as well as equipment, so there should be hopefully some upside there.

I think -- we still think that operating margin expansion is very doable for us.

It may not be exactly 20 basis points, maybe a little bit below that for 2018 but we still feel like there's a lot of opportunity to be more efficient, leverage the infrastructure, et cetera, to achieve that.

And it's important to our financial model to be able to achieve that.

So we're still calling for overall operating margin expansion.

Your next question will come from the line of Jeff Johnson with Baird.

So, yes, maybe one more follow-up question on guidance for next year.

And then I do have a DSO question as well.

But Steve, on your tax rate guidance for next year, by my math, that's about a dime or so about 2.5 points to EPS.

Just want to confirm that, that math year-over-year is at least ballpark accurate.

And then to the point you just made, it would seem to imply then that your guidance for next year on the operating margin line is flat to maybe up 10 basis points or so.

Is that about ballpark accurate as well?

It depends on -- I think your math is correct.

It depends on where in that 1 to 2 percentage points we end up because as you can imagine, there are a lot of moving factors in an effective tax rate.

And we still are trying to estimate for this stock-based compensation.

We still have to estimate the number of shares that will vest next year as well as what the stock price will be on that vesting date.

So it's a little bit of things beyond our control in order to be very precise on that.

But yes, it is a significant headwind for us.

With respect to overall margins, and I said on the last question that I think it'll be a little bit lower than the 20 basis points, so that's in line with what you're saying.

But we still expect to get overall margin expansion in 2018.

All right.

Then the follow-up on that, and it's kind of tied to DSOs.

I think we've all heard of 1 or 2 of the big renegotiations that have happened here recently.

But what percentage of your DSO contracts are now locked in for maybe a multiyear basis?

Or what are the odds that we get into 2018 and there is another kind of big round of renegotiations that we have to think about impacting as we go then into 2019?

Just any comfort or any kind of color you can give us on where you are with your DSOs and how we should think about the next few years on a contractual basis?

Yes, it's a good question, Jeff.

So we believe that at this point, all of our major DSOs have multiyear agreements.

Yes, there are some smaller ones that are not multiyear at this point.

But I think the risk is all behind us.

I think the fact that all of the major ones now are tied up in long-term agreements, means that the risk, while -- it's not that there is no risk going forward.

It's really much smaller than before this.

Jeff, let me just add that, I think it's becoming clearly understood amongst the DSO community as well as the mid-market community, that Henry Schein brings unique value not only on the supply chain side, but on the consulting side and increasingly, on the software side.

So every now and again, every few years, we do have a loss of an account, so pick up multiple accounts in that period.

So I think this market is quite stable and we are enjoying very good relationships with our large accounts.

I have to say I've spent time with a few of them recently, and the feeling that Henry Schein provides the value that they are seeking as they're growing their business reach is quite high.

So I think we're in pretty good shape.

Your next question will come from the line of Steve Beuchaw with Morgan Stanley.

Maybe first one from me is actually on Europe.

I really appreciate the narrative that you just gave there on the DSO dynamics.

It would be really helpful on the gross margin front if you could just expand a little bit on some of the earlier commentary on Europe and margins and help us understand how things are evolving there?

Well.

So Europe, as people probably know, is still a market where there's still many, many smaller distributors out there.

And again, I think for us, we feel like there's a big opportunity still in Europe especially on the margin -- even though the margin was contracting right now.

But again, we need to continue to advance all of our Value-Added solutions in order to bring more value to our customers, so they're not focused on the price of that less product even though we intend to be very competitive.

But we do more than just get products efficiently to customers at a very good price.

We want to show all the value-add that we need to get compensated for also.

So it's still a very small market.

Most of the players are really just competing on price.

They don't have the value-add.

They don't have anything other than price and a little bit of relationship to compete on.

So over time, I think we'll have nice opportunities improving that.

And then a quick follow-up for me is actually on U.S. dental equipment.

I wonder if you could just talk about given some of the changes that you've made both with regard to E4D and with regard to DENTSPLY SIRONA, how do you think about the trajectory of the U.S. dental equipment business within '18?

We're quite optimistic, feel pretty good about the equipment market in the U.S., actually globally at the moment.

I think there is a good movement towards dentists investing in their practices in the traditional equipment area.

I think we're doing well with A-dec.

I think the Danaher, Midmark, other manufacturers, including Planmeca, I think they've invested in their offerings, and these are well received by the customers on the traditional side, shares, unit [slides].

On imaging, I think there is still a lot of momentum to adding the digital imaging into the practice, still some practices that don't have it and there are practices upgrading.

And CAD/CAM is the area of great excitement.

This can only -- we continue to do well there with quite a large offering.

The systems are by and large either integrated into Dentrix, Easy Dental, Exan, college system, the dental school system where they're about to be integrated, and I think there's huge opportunity there.

And in the chairside units, I think full chairside, CAD/CAM, lots of excitement there.

I think the Henry Schein salespeople add excitement to the marketplace, encouraging dentists to look at the full system, the addition of the Sirona line to us, the expansion of the offering by Planmeca.

All of this adds excitement to the CAD/CAM chairside arena and there is a lot of activity going on in the laboratory, as the laboratory moves from manual to digitalized dentistry.

So we remain quite optimistic about equipment.

I believe Steven mentioned our pipeline is quite good going into the fourth quarter.

I think last year, we had about 30% growth in the third quarter.

So if you average that out with now this past quarter, 6%, 7% or so growth is quite good.

It's certainly more than the market is growing.

We are excited about this area both from the interest of the dentists in equipment and equipment technology and our ability to continue to grow market share, tying that into our digital practice solutions platform as well.

And your final question will come from the line of Jon Block with Stifel.

I'll ask maybe just one question with 2 parts.

Steven, I may have missed this, but did you give any concrete numbers to sort of traditional consumable growth versus at a specialty?

And then the second part would be, Stanley, within traditional consumables, do you see any increased risk of, call it a subset of these traditional consumables going to a pure online provider, possibly at slightly lower cost?

Yes.

So on the first piece of your question, I didn't give specifics, but the specialty sales growth did grow faster.

I think it was in the mid-single digit range.

I don't have the exact number in front of me.

But somewhere in the mid-single digit range.

So yes, it continued to grow faster than the core consumable number.

So I think as, Steven -- you're asking a very important question on the digital standalone potential consumer distributors.

There has always been price driven components in dentistry.

This has been the case for almost 40 years.

Henry Schein built out initial business on coming out with a catalog, listing prices of all products, having those prices in stock and having great fulfillment.

We were able to get to about 8% market share and could not go beyond that because dentist need much more than the consumable products at a discounted price, if you will.

So 2 points.

One is that there are several companies out there that are started out as mail order, moved to telesales and now are digital platforms.

We have interest in those companies throughout the world, including 1 in the U.S., the biggest.

And these market -- these businesses grow but they don't grow much differently to the traditional full-service dealers in term of consumable products.

The key here is for us to continue to offer the Value-Added services, so that our value, mainly that of our field sales consulting force.

Today, about 4,500 people around the world remains relevant and that the customers are prepared to pay and they pay some amount for those consultants to visit them, provide them with consulting advice on how to run their practice on clinical efficiency, on quality of care, on simple business questions like where can I find somebody to help me run my office when I lost a General Manager or lost somebody at the desk.

I need to understand somebody could help me use Dentrix.

I need to help -- find somebody who can help me do my marketing, all those kinds of things is a huge value in that.

So we believe that the Value-Added service part of the offering continues to grow in importance and we're investing heavily in that area.

So the digital platform is an ordering platform, sometimes offered by standalone companies that only offer consumable products and there's a part of the market that goes there.

And if it becomes really a price issue, well, Henry Schein has the largest variety of private brand, control brand products in the industry.

We have practically everything a practitioner may need at very good prices.

And if it becomes a price situation, we can win on that only if that's the only issue.

So there are a lot of challenges that we have to face in our business like every other business.

But to me, this is not on the top of the list.

This is an area we have to focus on.

We have to focus on our digital software platform.

We're investing in that part of the expenses, additional expenses in 2016, '17 and certainly, '18, '19 and '20 will be in the area of software to make our ordering platforms even more efficient, more user-friendly, tying it into automatic order replenishment, video capability for particular product offerings, study clubs, all that kind of stuff.

I don't think that, that is something that our competitors in the supply chain only will be able to compete with.

Having said that, I think they will remain a size of the market of somewhere between 10%, 15% that'll be price only.

And in that market, Henry Schein will continue to compete and compete very well, although, on the major investment in the U.S., we do not even consolidate those sales.

But I will say that the growth there is not much different to us being in the Henry Schein core business.

So we need to invest in a lot of areas.

Of course, in the digital platform and in our Value-Added services in general.

And I think those investments will be well worth it and continue to help us create shareholder value in the years to come.

Jon, let me just update the dental specialty growth.

Actually, I looked at the number.

It's a little bit higher on a global basis.

I said mid-single digits, but on a global basis, it's almost 10%.

So I just wanted to update you on that.

So, thank you all for calling in.

Really remain excited about where we're heading.

I think we need to continue to invest in the business as I described.

I think we will continue to do well in our basic consumable and equipment businesses, dental, medical, vet and laboratory.

And I'm particularly excited with the opportunity of increasing our operating profits as a result of the work we're doing in the specialty areas and in the practice solutions software areas.

Of course, all the while increasing efficiency in the business while providing the best of products at the best value offering to our customers.

So remain very excited about where we're heading.

Steven can be reached at 631-843-5915.

Carolynne Borders can be reached at 631...

390-8105.

And they're both heading out now to the investor conference in Arizona.

And they're available if people have questions.

So thank you very much.

Thank you for joining us to discuss Henry Schein's results for the third quarter of 2017.

You may now disconnect.